The interchange fee is basically what the credit card industry calls the fee that merchant banks pay to the customer’s bank whenever the merchant accepts a credit card with one of the major networks (Mastercard, Visa, etc.). When a credit card is used at a merchant the customer’s bank automatically deducts its own interchange fee from the total amount charged when it pays the merchant.

Interchange fees vary according to a number of factors, including the credit card network used, the type of purchase that is made (groceries, gas, ATM withdrawal, etc) and more. The formula to reach the interchange fee is quite complicated, although it’s often somewhere around 2%. Most often the rate is flat with a percentage of the purchase price added on. Interchange fees are very important to credit card issuers for a huge reason: they account for up to 90% of the fee revenue the bank receives. In 2005 alone almost $31 billion was made from interchange fees alone with Mastercard and Visa.

It’s important to understand the impact interchange fees have on the industry because there is quite a bit of controversy surrounding the practice. Many merchants are claiming that interchange rates are much higher than they should be, especially considering that technology has only improved while rates seem to increase each year. These interchange fees cut into profits for many companies, especially small businesses that can’t afford the 2% cut into their sales but can’t afford to turn away credit card-toting customers, either.

There’s another important aspect to interchange fees and it relates to rewards credit cards. Have you ever wondered why it’s lucrative for credit card companies to give you 1% (or more) back for every purchase you make, even if you never incur a single bit of interest? You have interchange fees to thank for that. While credit card companies are charging 2% on top of every purchase made with the credit card to the merchant they’re giving you back only half of this. That gives them a 1% potential profit on every purchase that’s made with a rewards card.

Interchange fees are an important part of the credit card industry and things would be much different without them. That’s why it’s necessary to understand how they work so you better understand that bit of plastic you use every day.

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